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Published online by Cambridge University Press: 11 April 2018
We investigate whether short sellers contribute toward the informational efficiency of market prices by trading on their private information or destabilize market prices by trading on rumors and false information. We find that short-selling activities are considerably informative about future stock returns when there is a higher likelihood of private information in stocks, as measured by insider-trading activities. Short sellers also bring considerable additional information to the market that is not fully captured by contemporaneous insider trading. Overall, these results suggest that on average, short sellers bring informational efficiency to market prices rather than destabilize them.
We thank an anonymous referee, Hendrik Bessembinder (the editor), Brad Barber, Sunil Wahal, Kent Womack, and seminar participants at the University of Michigan, Koç University, and Risk Management Association of University of North Carolina (RMA, UNC) Academic Forum for several useful suggestions. All remaining errors are our own.